The dimensions of economic substance
Dr. Constantin Frank-Fahle, Marcel Trost, and Varun Chablani explore the United Arab Emirates’ economic substance requirements, highlighting recent Federal Tax Authority clarifications on compliance thresholds, evidentiary layers for distribution activities, potential tax benefits for large businesses and the R&D sector, and VAT-specific requirements in this moderate-tax country.
Economic substance has various dimensions in the United Arab Emirates (“UAE”). At the domestic level, it manifests mainly under the Qualifying Free Zone Person (“QFZP”) concept, wherein businesses may claim a special 0 per cent Corporate Tax (“CT”) rate under certain conditions, rather than the standard 9 per cent. One of the conditions that QFZPs need to fulfil is to “maintain adequate substance”, failing which the benefit is lost for at least 5 years.
At the international level, the substance concept is viewed through the lens of Transfer Pricing, special rules relating to large businesses, and benefits to research-heavy industries.
ADEQUATE SUBSTANCE: WHAT DOES IT MEAN, AND HOW MUCH IS NECESSARY
Art. 18 Federal Decree-Law No. 47 of 2022 and Art. 8 Cabinet Decision No. 100 of 2023 mention that the QFZP needs to “maintain adequate substance” in the UAE. This has been understood to mean:
- All of its core income-generating activities (“CIGA”) must be conducted in a Free Zone;
- Adequate assets, qualified full-time employees, and operating expenditures in the Free Zone to perform the CIGA – depending on the level of activities carried out;
- In some cases, these activities may be outsourced, as long as there is adequate supervision of the CIGA.
This understanding led to uncertainties on some positions. One open question was whether a shared workplace in a Free Zone meets the criteria. The FTA has recently indicated that if the shared workplace is sufficient to carry out its CIGA and is commensurate with the level of its activities, then (depending on the circumstances) the QFZP may be considered to have maintained adequate substance (which overall requires adequate assets, an adequate number of qualified full-time employees, and an adequate amount of operating expenditures).
Likewise, it is also clarified that where employees hold work visas issued by other Related Parties, that does not prevent the QFZP from meeting the adequate substance requirement of having an adequate number of qualified full-time employees in a Free Zone. Here too, the QFZP must bear the economic expense of the employee and must be responsible for the substance of the employment relationship.
Another open question clarified recently is with respect to the 0 per cent CT benefit for the specific activity of “distribution in or from a Designated Zone” – i.e., certain fenced Free Zones in the UAE (such as Abu Dhabi Airports Free Zone – ADAFZ or Jebel Ali Free Zone Authority – JAFZA). Multiple compliance requirements were recently brought in with respect to the distribution activities by way of FTA Decision No. 6 of 2026. These include obtaining an Agreed-Upon Procedures (“AUP”) Report from an independent external auditor demonstrating compliance with the requirement to verify reseller status of the customers and the importation of goods or materials through a Designated Zone (evidenced via written declarations of the customer, valid business, trade, or commercial licences or any equivalent document held by the customer that is indicative of reselling licence, etc.). This leads to an extra step for such distribution entities while onboarding their customers. To some extent, the FTA has ensured that the evidentiary responsibility is not only maintained by the taxpayer, but also certified by an auditor, as a measure to have more standardisation and efficiencies in their audits.
These aspects reveal the importance of substance and the purposive interpretation of having adequate substance in the UAE.
ECONOMIC SUBSTANCE IN INTELLECTUAL PROPERTY-DRIVEN BUSINESSES
Another interesting aspect of economic substance in the UAE is for the specific treatment of Research and Development (“R&D”) incentives, and its related concept “Qualifying Intellectual Property” (“QIP”).
The R&D incentives allow businesses in Phase 1 to receive a non-refundable credit (between 15 per cent and 50 per cent) against certain tax liabilities (regular CT at 9 per cent as well as the Pillar Two top-up tax). It is important to note that the tax credit is based on the Qualifying R&D Expenditures (e.g., staff costs, consumables, etc.) and the minimum staff required for conducting the Qualifying R&D Activities (determined based on international standards of novelty, creativity, uncertainty, systemisation and transferability/reproducibility).
Being an “expenditure-based” incentive, this is particularly impactful for research-heavy businesses incurring significant expenditures before generating the corresponding income in future years. Businesses seeking this benefit are encouraged to organise their data, plans and expenditure budgets such that estimated profits may be arrived at – so that their pre-approval mechanism for claiming the benefit materialises.
Turning to QIP – such as patents, copyrighted software, and other rights that have legal protections – QIP constitutes a “Qualifying Income” which in turn may be eligible for the 0 per cent CT benefit. The income itself is factored against “Qualifying Expenditures” (i.e., the total expenditure directly incurred to fund the R&D activities).
ECONOMIC SUBSTANCE FOR LARGER GLOBAL BUSINESSES IN THE UAE
There is yet another layer of consideration upon maintaining economic substance for larger global businesses operating in the UAE. A separate “top-up tax” applies only to such businesses that have global revenues exceeding EUR 750 million (around AED 3.15 billion). Such businesses need to pay, effectively, a tax up to 15 per cent (and not merely the standard 9 per cent or 0 per cent as for most businesses). This additional obligation can be reduced where the business maintains sufficient economic substance, factored via the carrying value of tangible assets and payroll.
ECONOMIC SUBSTANCE FROM A VAT PERSPECTIVE
From a Value Added Tax (“VAT”) perspective, businesses seeking to avail Input Tax on sizeable supplies need to verify the identity, business activities, risk profile and commercial circumstances of their suppliers. This, too, places greater onus on businesses to establish the genuineness and economic substance of the supplies as a condition for claiming Input Tax.
CONCLUSION
Maintaining adequate economic substance in the UAE is no longer just a regulatory formality, but a vital strategic requirement to secure critical tax benefits, such as the 0 per cent CT rate for QFZP, key R&D incentives, and the ability to claim Input Tax. By providing clear guidance on compliance thresholds and audit-ready evidentiary layers, the legislature and the FTA highlight that robust, documented operational presence is essential for both local enterprises and large global businesses to optimise their tax positions.
Text by:
- DR. CONSTANTIN FRANK-FAHLE, LL.M., founding partner, emltc (Emerging Markets – Legal. Tax. Compliance.), Abu Dhabi/Dubai, UAE
- MARCEL TROST, LL.M., founding partner, emltc (Emerging Markets – Legal. Tax. Compliance.), Abu Dhabi/Dubai, UAE
- VARUN CHABLANI, LL.M., ADIT (CIOT, UK), senior associate, emltc (Emerging Markets – Legal. Tax. Compliance.), Abu Dhabi/Dubai, UAE
